Real estate

Even as the market is now surging on rumors of massive pan-European bail outs (someone explain to us how a tsunami of failed banks is equity positive... or for that matter how imminent monetization is EUR positive), Bloomberg is reporting that the liquidity crisis in Europe has struck smack in the middle: after the FinMin released a draft bill to forcibly write down real estate asset holdings by 10, investors in certain mutual funds have panicked and attempted massive redemptions, which in turn forced redemption halts by these funds which likely are woefully undercapitalized to begin with. This is just the beginning of the liquidity squeeze moving from the periphery to the core.

With populations soaring at the bottom end of the economic spectrum, the demand for new apartment buildings is going to be huge. Immigrants joining impoverished gen Xer’s and Millennials aren’t going to live in cardboard boxes under freeway overpasses. Institutions combing the landscape for low volatility cash flows and limited risk are starting to pour money in.

If Goldman Sachs wanted to reduce its exposure to subprime mortgage investments, why didn't it simply sell the assets it owned? Two reasons: First, those large sales would have sent a signal that something was terribly, terribly wrong, and thereby pushed prices down further. That's how supply and demand normally works. Second, Goldman professed to be market maker, which uses its trading book to instill confidence. It ostensibly bought, sold and inventoried mortgage securities to provide stability and liquidity to the marketplace. Of course, we now know that such market confidence was entirely misplaced. To sidestep these issues, Goldman and other major banks found a solution that subverted the laws of supply and demand, and escaped the price discovery of a transparent marketplace. They fabricated synthetic CDOs, such as Abacus 2007 AC-1. These toxic assets, invented out of thin air, made the meltdown worse than it otherwise would have been.

Richard Koo's latest observations on the US economy are as always, a must read. The critical observation from the Nomura economist explains why the realists and the naive idealists are at greater odds than ever before: the government continues to perpetuate, endorse and legalize accounting fraud in the hope that covering everything up under the rug will rekindle animal spirits. The truth, as Koo points out, is that were the FASB to show the real sad state of affairs, the two core industries in the US - finance and real estate, would be bankrupt. "If US authorities were to require banks to mark their commercial real estate loans to market today, lending to this sector would be extinguished, triggering a chain of bankruptcies as borrowers became unable to roll over their debt." In other news Citi, Bank of America, and Wells just reported fantastic earnings beats on the heels of reduced credit loss provisions. Nothing on the conference call mentioned the fact that all would be bankrupt if there was an ounce of integrity left in financial reporting, and that every firm is committing FASB-complicit 10(b)-5 fraud. One day, just like Goldman's mortgage follies, all this will be the subject of epic lawsuits. But not yet. There is some more money to be stolen from the middle class first, by these very firms.

In the rush over Goldman coverage and volcanic news, a very relevant piece of market update may have gotten lost, namely that Moody’s/REAL All Property Type Aggregate Index just peaked once again. Moody's reports that this index "measured a 2.6% price decline in commercial properties in February. This decrease comes on the heels of three consecutive months of rising prices, and brings the level of commercial property prices 41.8% below the peak measured in October 2007. Values are now down 25.8% from a year ago, and 41.6% from two years ago." This is the first time prices have fallen since October of last year: have we just hit price resistance in CRE?

How many ways can a Wall Street Banker bend over an institutional client before they scream "ouch"??? Let me count the ways (with a spreadsheet, may I add)...

Europe faces a commercial property debt timebomb with almost €1 trillion (£896bn) outstanding from the sector and a quarter of that potentially distressed. The UK accounts for 34% of the €970bn total, with Germany second with 24%. Not to worry, global pension funds are busy snapping up properties but do they really know how long it will be before this crisis blows over? And what if it gets a lot worse before it gets better? Are pensions prepared to deal with those losses?

While anal-ytic 'debate' about whether Chinese real estate prices have reached nose-bleed territory continues in merry-go-round circle-jerk fashion, there is only one (very simple) question to ask:

is this the kickoff to a new bull market in Chinese RE or a terminal throw-over (cause there ain't anything in between) ?

We have so far avoided discussing this weekend's most tragicomic news, which undoubtedly is the Mortgage Bankers' Association selling their headquarters for a huge loss in less than two years. The building which was acquired for $76 million was sold to CoStar for $41.25 million. How the MBA is in any way supposed to provide insight on sentiment and market perspectives after a slap in the face such as this is beyond us. At best, they should start a $2.95 newsletter titled "How to top tick the market and never look back while waiting for the Dow 36k." The other implications of this transaction are self-explanatory. Yet courtesy of diligent readers, we have received some other very amusing information, which however focuses on the buyer in this transaction, specifically CoStar, which on its website brands itself as the "#1 Commercial Real Estate Information Company." Apparently the validity of this branding is only as good as the (un)solicited hot tips CoStar receives every day. A letter sent out earlier by an editor of CoStar's Watch List Group seeks to expand on the groupthink permeating the permabullish CRE investor landscape (we hope they approached Cohen and Steers with their query for an objective and unbiased perspective), with a set of questions that makes one question the validity of CoStar's self-branded imprimatur.

Even as ever more Congressmen express concern about the implications of the ongoing CRE "bubble" (yes, this is a quote), S&P comes out with a report noting that should the banking system be forced to take all appropriate CRE-associated writedowns, it likely would not survive. And all this is occurring as REITs probe new 52 week highs. Welcome to the new economy.

Harry Reid hopes to have enough votes to proceed with Bernanke's reconfirmation by Friday. More relevantly, Harry Reid hopes to have secured the value of his Commercial Real Estate holdings likely valued at over $3 million from collapsing should the Chairman not be reappointed, and have the opportunity to sell, sell, sell. But all Senators who have acquiesced to Reid's prodding for a Bernanke vote knew all this already. Right? After all, this is in no way a conflict of interest.

CRE is still the biggest wildcard: "Commercial real estate was still weak in nearly all Districts with rising vacancy rates and falling rents. Since the last report, loan demand continued to decline or remained weak in most Districts, while credit quality continued to deteriorate." - Beige Book

While some China Bears are busy publicizing prediciton of an utter Dubai or Enron-like collapse in China, Beijing is actually in the process of rebalancing its economy and an overheated real estate market. And gold is poised to benefit the most from this shift.

excerpted from The Stamford Review, 2009: Volume Two, "Mortgages, Finance Markets, and the Imperative of Growth" by Hugh Kelly

How high can home prices go with a ten year inventory overhang? Baby boomers are about to suck the life out of this market. No “rosebud” for me. The first in a series of seven on The Mad Hedge Fund Trader’s Annual Asset Allocation review.